Economists: ‘Most Disappointing Feature’ Of Bank Plan Is Lack Of Financial System ‘Reorganization’

ap090131012057Courtesy of Hendrik Hertzberg, we have two Nobel prize winning economists — Joseph Stiglitz and Robert Solow — saying that the “most disappointing” aspect of the Obama administration’s economic plan is that it seems to imply a return to Wall Street’s pre-crisis status quo:

They see the lack of a thoroughgoing “reorganization of the financial system” as the “most disappointing” feature of the new dispensation…Stiglitz said he has the impression that while the Administration’s policymakers are familiar with the approach he and Solow advocate and have discussed it among themselves, it hasn’t been given the kind of in-depth consideration that has been extended to the solutions preferred by the big banks. “When push comes to shove,” Solow said, “politics wins over economics every time. It’s the unanswerable objection: ‘You can’t get it through Congress.’ ”

This ties back to Matthew Yglesias’ concern that “Obama is unduly optimistic about the idea that we can keep the financial industry basically as is, but regulate it ‘better.’” “The pre-crash state of regulation had a lot to do with the political clout and prestige of the institutions in question. If you keep the same institutions in place, I worry that they’ll swiftly recapture the regulators,” he wrote.

This is a very legitimate concern, and one the administration has done little to address. Obama said last night that he expects “to sign legislation by the end of this year that sets new rules of the road for Wall Street.” But more than new rules are needed. There has to be a fundamental change in the nature of institutions, so that they don’t become too big to fail. As FDIC Chairman Sheila Bair said this week:

Investors and creditors have lacked strong incentives to perform due diligence because of the perception that these institutions are so large and complex that the government would have to bail them out. And they were absolutely right…This is unacceptable, and simply reinforces the notion of “too big to fail”…a 25-year old idea that ought to be tossed into the dustbin.

The big banks still have a lot of sway on Capitol Hill, and as MIT professor Simon Johnson said “I think [the administration has] been too deferential to big finance…I think they should be more willing to take them on.” Of course, it would be nice if this weren’t a unilateral fight, but one that the administration and both parties in Congress joined, in the interests of sustainable economic growth. The president can use his bully pulpit to outline a new direction, but it will take a concerted effort across the board to ensure that Wall Street doesn’t gamble the economy into oblivion again.